Academic journal article New England Economic Review

Unemployment Insurance Policy in New England: Background and Issues

Academic journal article New England Economic Review

Unemployment Insurance Policy in New England: Background and Issues

Article excerpt

Almost two-thirds of the states, and all the New England states except New Hampshire, have exhausted their unemployment insurance trust fund and borrowed from the federal government at least once during the past 35 years (U.S. Department of Labor 1995). Under such circumstances, states are required by law to raise unemployment insurance taxes in order to replenish their trust funds and to pay off their debts to the federal government. Since higher unemployment insurance taxes increase employer costs, replenishment forces states into a trade-off between economic competitiveness and trust fund adequacy. In recent years, intensifying competitive pressures have caused many policymakers to question prevailing standards of adequacy and the speed at which they should be attained. Consequently, several states, including some still in the process of rebuilding reserves depleted by the last recession, are contemplating tax reductions.

This article provides background information and analysis intended to clarify issues underlying the unemployment insurance (UI) policies of New England in general and a tax reduction under consideration in Massachusetts in particular. The article's main point is that alternative UI policies should not be judged solely by the yardsticks of economic competitiveness and trust fund adequacy. Allocative neutrality and economic stabilization are also relevant concerns. UI systems necessarily force some industries to subsidize others, thereby distorting the allocation of resources in favor of subsidized firms. Yet, many of the same features responsible for these allocative distortions affect economic stability. Every UI alternative entails trade-offs among these rival concerns.

The article is divided into five sections. Section I explains the rationale for public provision of UI. Section II analyzes the structure of UI benefits and evaluates the relative generosity of those provided by the New England states. Section III explains how benefits are financed and compares UI tax burdens in New England with those imposed by other states. Section IV explains how certain features of unemployment insurance taxation create cross-industry subsidies that affect resource allocation. Evidence is presented concerning the extent of such subsidization in Massachusetts. Section V discusses proposed UI tax reductions in Massachusetts and Vermont, as well as some alternative reforms.

I. Why Do Governments Provide Unemployment Insurance?

In an industrialized society, every worker, no matter how competent, faces the risk of becoming temporarily unemployed. This risk creates a demand for insurance that provides partial wage replacement between jobs. A market for such insurance will not form spontaneously because this risk is spread so unevenly. Workers in volatile industries, such as construction and the manufacture of automobiles, face a higher risk of being laid off than their counterparts in stable industries, such as public utilities and financial services. If unemployment insurance were voluntary, the latter group of workers would break away and form their own low-risk pool. As a result, workers with a severe risk of unemployment would face prohibitively high premiums. To ensure provision of UI, governments can either require high-risk employees, or their employers, to pay high premiums or arrange for their premiums to be subsidized. The UI system of the United States partially subsidizes the premiums covering high-risk workers through a payroll tax collected from employers.(1)

If governments financed unemployment compensation solely on a "pay as you go" basis, obligations for social assistance during recessions might become too heavy to bear. By compelling firms to contribute regularly to a trust fund on behalf of their workers, governments are more likely to have the fiscal capacity to provide assistance to the unemployed when needed.

Forcing employers to pay more UI taxes during "good" times so that benefits can be paid to the unemployed in "bad" times ("forward funding") stabilizes the economy by smoothing consumption. …

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